An Analysis of the Carter Anti-Inflation Program

About the Author

67 October 25, 1978 AN ANALYSIS OF THE CARTER ANTI-INFLA TION
PROGRAM THE ISSUE One of the few sounds that has been heard above
the rumble of rising prices is the angry cry for an inflation
policy. The past redistribution of wealth and the promise of future
income distortions have prompted a unanimous and relentless clamor
for action. President Carter's responseto the call was presented
October 24, 1978, in the form of voluntary wage and price controls
and government restraint.

Even before the announcement, the program had generated con
siderable criticism from both labor. and business leaders. Many are
skeptical about the effectiveness of a voluntary program.

Some believe that "voluntary" is merely a necessary prelude to
mandatory The Administration itself does,not hold a great deal of
hope for the effectiveness of the program. Although the official
tar get is a 1.5 percent cut in the inflation rate, a more
realistic figure is one-half of one percent.

Inflation promises to be a most redoubtable foe. Next year's
major wage contracts, in trucking, auto industries, and oil, among
many others, threaten to boost the wage-price spiral into
orbit.

The Federal Reserve has persistently exceeded its stated money
supply targets. The decline of th e dollar, itself in part inspired
by inflation, has contributed to the decline in purchasing power
through higher priced imports. The dismal productivity perfor
mance, pushing up unit labor costs, promises to exert even more
upward pressure on prices 2 BA C KGROUND The currently voluntary
wage and price controls are actually Phase I1 of the "deceleration"
program announced last April. In that version, business and labor
were asked to hold increases below the average of the previous two
years. The Administrat ion in an attempt to lead by example,
limited government white collar increases to 5.5 percent. Promises
to limit budget deficits and inflationary regulations were also
part of the package.

Enforcement was practiced through the gentle art of suasion or
jawboning. As attested to by the current situation, the "de
celeration" program was a failure THE PRESENT PROGRAM The present
voluntary program, retroactive to October 1, calls for annual wage
increase ceilings of 7 percent. This standard applied to executive,
union, and non-union pay, also includes fringe benefits pay
increases and are subject to the guidelines. Multi-year contracts
must average no more than 7 percent a year. Existing contract s are
excluded. Union wage contracts above 7 percent are permissible if
accompanied by work rule changes which reduce costs.

Those earning less than four dollars an hour will be exempted
from the stricture Cost-of-living adjustments would be considered
The package also contains a "Real Wage Insurance" proposal designed
to make the wage guideline more palatable. Should the inflation
rate exceed 7 percent, workers who have accepted wage contracts of
less than 7 percent would receive the difference between th e
inflation rate and the 7 percent standard in tax re bates.
I-:-T-his"proposal, however, must first obtain congressional
approval Prices, while not tied to a specific figure, are to be
held at least one-half percentage point below the 1976-1977 average
in creases. This is very similar to the Phase I guideline. In
practice, this will limit increases to a 6 to 6.5 percent
range.

Those firms which benefit from substantial cutbacks in labor
settlements are expected to cut prices by more than one-half per
cent. Firms facing oppressive costs will be permitted to increase
There is, however, a 9.5 percent ceiling, on each product, regard
less of cost prices accordingly, but profit margins are to remain
the same.

The Council on Wage and Price Stability will monitor develop
ments on a day-to-day basis. There will also be periodic reviews 3
of large corporations. To carry out these tasks, a staff increase
of 100 to 200 is required. Many of these have been drafted from
existing agencies. The 400 largest corporations al so have been
requested to make available to the Council on Wage and Price
Stability weighted indices of all manufactured profits. This
request is enforceable by subpoena.

Enforcement of the voluntary standards is in the hands of the
Office of Management an d Budget. This will also necessitate a
staff increase. Firms bidding on federal contracts over five
million dollars, must demonstrate, in advance, that they are op
erating within the guidelines. Offenders are expected to be hit by
a loss of federal purcha ses and construction contracts. The OMB
controls purchases of 80 billion. The White House is also expected
to use the power of public censure to promote compliance.

An example of the type of pressure that will occur was reported
in the Wall Street Journal (October'20 1978 To ensure sufficient
resistance to the upcoming 'Teamsters contract negotiations, the
ICC, at the Administration's behest, has warned trucking firms that
cost increases may not necessarily be passed on in higher rates On
the labor side, t he Washington Post (October 24, 1978) reported
that the Administration is studyinq alternative methods of
computing wages paid to privately-employed labor working on federal
projects.

A less controversial aspect of the program is President Carter's
proposal for government restraint.

The Administration has pledged to minimize the inflationary
effects of government regulation. To accomplish this, a "Regula
tory Council composed of inflation specialists and representa tives
of selected independent agencies,.s uch as OSHA and the EPA has
been established.

The program also includes a plan to limit the 1980 budget
deficit to 30 billion. The proposed 1979 deficit is an estimated 40
billion. An additional element is a partial freeze on hiring No new
positions are t o be created and only 25 percent of existing
vacancies are to be filled ANALYSIS The Administration's plan to
limit the role of government promises to have a.positive impact on
inflation. Barry Bosworth director of the Council on Wage and Price
Stability, estimates that regulation accounts for three quarters of
one percent of the current inflation. An evaluation of the
inflationary aspects of future regulations is a step in the right
direction.

The promise to cut the budget deficit, while still only a prom
ise, bodes well for the future. It implies less government spending
and will permit the Federal Reserve to pursue a more 4 restrictive
monetary policy. However, the proposed "Real Wage Insurance" might,
if enacted, have a significant effect on the size of the deficit.
Rebates if the inflation rate exceeds 7 percent, could be
substantial, particularly since federal workers, now limited to
wage increases of 5.5 percent, are to be included.

The outlook for the wage and price controls is not so Wage and
price controls function, primarily, by squeezing optimistic profit
margins. Increased cos.ts are not passed on in higher prices, but
rather absorbed through a decrease in profits objection to the
voluntary, or any future mandatory wage and price controls is tha t
by squeezing profits, controls endanger the future of the economy
Price increases are not eliminated under this policy, merely
postponed unfairly and inaccurately cast business and labor in the
role of the originators of inflation The Wage and price cont r ols
also PROF ITS Profits perform a critical and vitalizing function in
our economy. When retained, profits finance expansion and research
When distributed, profits offer inducement for investment and
consequently, growth. The prospect of diminishing prof its
threatens not only the return to corporate shareholders, but also
the degree to which our economy can expand.

The imposition of wage and price controls is, particularly at
this time, a dangerous policy. Profits are, and have been for
several years, bel ow their historical post-war levels. Further
more, the current reports dramatically exaggerate the true level of
profits. Finally, due to the nature of the inflation process prices
lag behind cost increases HISTORICAL LEVELS There are a variety of
conflic t ing theories to explain the recent decline in secular
prices. There is, however, no dispute that profits have indeed
fallen. Profits, as a percentage of national income, exceeded,
sometimes .substamtially the 10 percent level in every year from
1946 throu gh 1969.

At the same time, real GNP in 1972 dollars increased from 981
billion to $1.27 trillion He also increased in Perhaps even more
distressing is Terborgh's calculation of The profit distortion is
further exacerbated by the federal tax system. The effective r ate
on real profits, as determined by the Terborgh study, has increased
from 42 percent in 1966 to 56 percent in 19

76. The result is even less real profits for reten tion and
distribution.

Another factor constricting profits is the inflation process
itse lf. Demand pull inflation is transmitted initially through the
cost of raw materials, then labor, and finally prices. Firms up the
cost of raw materials and labor reflected in prices and the
wage-price spiral is under way which respond to excess demand by
first increasinq output, drive These costs are then later Higher
prices prompt cost-of-living increases The essential element is
that most firms do not anticipate rising costs but rather react to
them with a lag price freeze will leave many firms with cos t
increases already incurred but not yet reflected in prices A wage
and The immediate future brings with it even more-pressure on
profits. The exclusion of already existing contracts from con
trols, when coupled with the expectations of future inflation, p r
omises to promote substantial cost-of-living increases. Wage
contracts at large companies, settled in the first six months of
1978, were at a 10 percent annual rate. These contracts, in turn
serve as models for 1979 negotiations. In addition, many wage co n
tracts overestimate the rate of productivity, thus pushing unit
labor costs higher than expected. President Carter has rejected
suggestions that the January increments in the social security
taxes and minimum wages be postponed. These developments cloud t h
e dis mal profit picture even further that a purpose of the
Administration's tax proposal was:,to increase after-tax profits
and spur investment to the President contains several provisions to
assist business and boost capital spending been a constant the m e
among businessmen, politicians, and the press Ironically, the
Economic Report of the President for 1978 states The recent tax
bill sent The need for more capital spending had I 7 in the past
few years. Yet with the wage and price controls the Carter Adm
inistration abandons this target and instead, fol lows a completely
contrary course.

The Administration's about-face is..both unnecessary and ill
advised tion. The oft-repeated dictum that "wage and price controls
treat the symptoms, not the disease" is tr ue Wage and price
controls will at best only delay infla A study by Robert L.
Schuettinger andEamonn F. Butler Forty Centuries of Waqe and Price
Controls, to be published by The Heritage Foundation in November
1978, chronicles the history of wage and pric e controls from
ancient China to the present.

Some common characteristics seem to be shortages, black markets
and occasional political upheavals CONCLUSION Inflationis, above
all else, a monetary.phenomenon. Contin ually rising prices are
caused by excessi ve increases in the money supply, whether
inspired by expansive or accommodative Federal Reserve policy. The
cure, therefore, lies in following a restric tive monetary
policy.

Adherents of the cost push school of inflation claim that
monopolies and labor unions are the source of inflation plies a
certain degree of power olies possess such power, why haven't they
exercised it earlier?

It would be a most irrational decision to postpone achieving the
optimal price or wage That im The question is, if these mo nop
Furthermore, there is no evidence to indicate that business or
labor unions have recently gained, or are now gaining monopoly
power.

This makes it doubly difficult to ascribe inflation, defined as
con tinuously rising prices, to monopolies constantly pushing up
costs popular belief that business and labor are the perpetrators
of in flation this misconception, but also diverts attention from
the true source of inflation, the government An unfortunate
by-product of this theory has been the widespread Th e use of wage
and price controls not only encourages President Carter's wage and
price control program is based upon a cost push theory of inflation
inflation with cost push tools is similar to performing surgery
with a hammer rather than a scalpel be a bl u dgeoned patient The
Carter Administration is hoping f0r.a one-half percent decline
in'inflation. This can be achieved, at least on a temporary To
attempt to cure a demand pull The most probable result will I 8
basis, but only at an enormous cost. To jeopa rdize the future of
the economy for a slight, fleeting, recision of the inflation rate
is a dangerous and desperate policy.